Integrated EUA and CER Price Modeling and Application for Spread Option Pricing

35 Pages Posted: 11 Jan 2011

See all articles by Pauline M. Barrieu

Pauline M. Barrieu

London School of Economics & Political Science (LSE)

Max Fehr

London School of Economics & Political Science (LSE) - Department of Economics

Date Written: January 10, 2011

Abstract

In this paper we propose a market consistent futures price dynamics model for cap-and trade schemes, designed in the spirit of the European Union's Emissions Trading Scheme (EU ETS). Historical price dynamics for the EU ETS suggest that, both, European emission Allowances (EUAs) and Certified Emission Reductions (CERs), certificates which are generated through the Clean Development Mechanism (CDM) - a non-domestic offset mechanism - are significantly related. We use an equilibrium framework to demonstrate that compliance regulation singles out special joint futures price dynamics. Based on this result we propose an arbitrage free futures price model and apply it to the pricing of spread options between EUAs and CERs.

Keywords: Environment, Asset Pricing, Stochastic Model Applications, Markov Processes, Economics

Suggested Citation

Barrieu, Pauline M. and Fehr, Max, Integrated EUA and CER Price Modeling and Application for Spread Option Pricing (January 10, 2011). Available at SSRN: https://ssrn.com/abstract=1737637 or http://dx.doi.org/10.2139/ssrn.1737637

Pauline M. Barrieu (Contact Author)

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

HOME PAGE: http://stats.lse.ac.uk/barrieu/

Max Fehr

London School of Economics & Political Science (LSE) - Department of Economics ( email )

Houghton Street
London WC2A 2AE
United Kingdom

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